Aug 2011 – Diversity or bust

Adrian Coles discusses a new report on diversity and promoting mutuals which he hopes the government will consider seriously in order to deliver on its coalition commitment

The document establishing the coalition government, published in May 2010, contained the following words: “We want the banking system to serve business, not the other way round. We will bring forward detailed proposals to foster diversity in financial services, to promote mutuals, and to create a more competitive banking industry.”

The coalition, in coming to the view that this course of action was desirable, probably drew on the idea that it was unwise for an economy to “put all its eggs in one basket”, and rely completely on the shareholder driven, profit dominated approach to the provision of financial services, after this had failed so spectacularly in the 2007-09 period. It seems likely that a varied set of institutions with diverse characteristics and motivations, within a given system, might be better able to withstand any stresses to which that system is exposed. Whatever the merits of the shareholder driven system it appears, a priori, unlikely that it is automatically best suited to all conceivable circumstances that might emerge.

Fish and finance

This view was best articulated by Bank of England executive director Andrew Haldane in a speech to the Financial Student Association, Amsterdam, in April 2009, in which he compared a financial system to a particular ecological system he described earlier in his talk.

“In explaining the collapse in fish and finance, lack of diversity seems to be a common denominator. Within the financial sector, diversity appears to have been reduced for two separate, but related, reasons: the pursuit of return; and the management of risk. The pursuit of yield resulted in a return on equity race among all types of financial firm. As they collectively migrated to high yield activities, business strategies came to be replicated across the financial sector. Imitation became the sincerest form of flattery.

“So savings co-operatives transformed themselves into private commercial banks. Commercial banks ventured into investment banking........

“Finance became a monoculture. In consequence, the financial system became, like plants, animals and oceans before it, less disease-resistant. When environmental factors changed for the worse, the homogeneity of the financial eco system increased materially its probability of collapse."

All-Party Parliamentary Group

Building on this perceptive analysis, the All-Party Parliamentary Group for Building Societies and Financial Mutuals has now come up with proposals as to how the government should deliver its coalition commitment.

Following a short inquiry, which included evidence sessions with the chief executive of the Financial Services Authority, Hector Sants, the financial secretary to the Treasury, Mark Hoban MP, the Association of Financial Mutuals, and the BSA, the group published its final report Fostering diversity: promoting mutuals in July.

As director-general of the BSA, I particularly welcome the following recommendations from the MPs:

• The government should adopt a comprehensive policy strategy to implement its coalition agreement commitment to promote mutuals.
• Legislation establishing the new regulatory authorities must include ‘promoting mutuals and fostering diversity’ within the statutory objectives.

• The government should fully consider remutualising Northern Rock and publish advice that it has received in relation to this matter.

• A government endorsed ‘Diversity Index’ should be established across the whole financial services sector.

Diversity Index

Relating to the final recommendation above, the BSA simultaneously announced that it had commissioned a consortium of academics from the universities of Oxford, Loughborough and the School of Oriental and African Studies at London University, led by Professor Jonathan Michie, Kellogg College, University of Oxford, to establish the diversity index.

The index will measure a number of factors - such as ownership structure, size and geography - across the UK mortgage, savings and current account markets. It will also provide an overall measure of diversity in each of these markets. It is intended the research will be published this winter, with the index then updated annually to assess how diversity is changing. Given that the government is committed to fostering diversity, it is surely key to the implementation of this policy that diversity is measured and all concerned can tell whether the coalition commitment is being delivered – indeed the index should be of interest to all those concerned with the creation of a healthy and robust financial services sector.

Government

The government has been in power for only a year, so there is clearly a limit to what it could have achieved in such a short period of time. However, there is a concern that the government has concentrated on the creation of new mutuals that might compete with established providers of public services, and has paid less attention to established mutuals in financial services.

With all of the thinking currently taking place on the future of financial services provision in the UK, at the Treasury Select Committee, the Independent Commission on Banking, and the members of the old regulatory tripartite, there is clearly an opportunity to improve diversity, rather than seek to recreate the old system. The thoughts of the All Party Group deserve full attention from all of those who wish to see a better future than the recent past.

Adrian Coles is director-general of the Building Societies Association